The 3% Signal

Overview

The 3% Signal is an investing plan that beats the general stock market by moving money into or out of a stock fund once per quarter based on the price of the fund only. When the fund grows 3% in a quarter, the investor does nothing. When it grows more than 3%, the investor sells the surplus profit and moves it into a safe bond fund. When it grows less than 3% or falls in value, the investor uses money from the safe bond fund to buy the stock fund up to the 3% growth line.

This simple action, using the clarity of prices alone, guides the investor to buy more of the stock fund when its price is cheap, and sell some of it when its price is expensive. The bigger the shortfall, the more the investor buys. The bigger the surplus, the more the investor sells.

This unemotional method — powered by prices, not opinion — beats the market. In so doing, it beats most professional advisors because the majority of them loses to the market.

The plan reduces investing stress by eliminating the need to monitor financial news and opinion, which issue conflicting advice based on “gut instinct” and other unreliable intuition. A key form of investing stress, the type caused by indecision, is eliminated by following the quarterly signal, which specifies how many shares to buy or sell.

The 3% Signal can be run in any account, including retirement accounts such as 401(k)s, IRAs, and Roth IRAs.

Introduction: Financial Floundering

One day long ago, I found my mother sitting befuddled behind a stack of stock market ideas. She pushed one of the reports my way and said, “I can’t make heads or tails of this. What do you think?” Heads or tails. That was an appropriate way to put it, I later discovered, because stock market advice is wrong half the time. My mother couldn’t make heads or tails of the ideas in front of her—and neither could the people who’d written about them. They were all just guessing.

So I embarked on a two-decade quest in search of a better way for ordinary people to tap the profit potential of the stock market. I wanted to free them from the unreliable advice of market pundits, steer them away from investment mistakes that cause stress in their personal lives, and show them how to avoid overpaying for underperformance. I spoke with widely praised professional money managers, read every book on the subject, subscribed to newsletters, wrote my own books and newsletter, and appeared in media.

My research revealed that parts of the investment industry are connected in a clever system designed to tease money from investor accounts and into the accounts of firms and advisers. It goes like this: Entice people onto the treacherous trail of stock picking and market timing, knowing they’ll fail; present alternatives that look more sophisticated than going it alone; then overcharge for those alternatives that actually perform worse than the unmanaged market itself.

What the experts don’t want you to know—but what you’ll never forget after reading this book—is that prices are all that matter. Ideas count for nothing; opinions are distractions. The only thing that matters is the price of an investment and whether it’s below a level indicating a good time to buy or above a level indicating a good time to sell. We can know that level and monitor prices on our own, no experts required, and react appropriately to what prices and the level tell us. Even better, we can automate the reaction because it’s purely mathematical.

This is the essence of the 3 percent signal. We set it as a constant performance line to return to each quarter, and then we either buy our way up to it or sell our way down to it. Used with common market indexes, this simple plan beats the stock market. Because most supposed pros lose to the market, the plan greatly outperforms them as well. This may seem too good to be true, and the pros want you to think so, but it’s not, and this book will prove it to you. The performance advantage of the 3 percent signal can be yours after just four fifteen-minute calculations per year, without a single moment of your life wasted on meritless market chatter.

Unlike most automated plans, this one acknowledges your emotional side, which sees news and wants to take action. To appease this impulse, the plan will show you the right action to take at a pace that’s perfect. You won’t jump in too often and create disorder; nor will you stay away too long and feel you’ve abandoned your investments. You’ll show up just frequently enough to keep your finances on track and yourself assured that everything is fine. This plan is all about getting the most out of the market for you in a way that satisfies your emotional needs as well as your portfolio needs.

We’ll begin with a look at how our instincts lead us astray in the stock market, and how so-called experts prey on these vulnerabilities. You’ll learn that the stock market is a zero-validity environment, and begin referring to pundits offering opinions on its future direction as “z-vals.”

Next, we’ll outline this book’s superior approach, the 3 percent signal. It requires only a stock fund, a bond fund, and a signal line. You’ll discover how to check in quarterly to see whether the stock fund’s growth is below target, on target, or above target, and then move money in the appropriate direction between the stock fund and the bond fund. This action, using the unperturbed clarity of prices alone, automates the investment masterstroke of buying low and selling high—with no z-val interference of any kind.

From there, we’ll explore the parts of the plan in more detail so you know what type of funds are ideal, why a quarterly schedule works best, how to manage cash contributions to the plan and occasional imbalances between its two funds, and when to implement a special “stick around” rule that keeps the plan fully invested for recovery after a market crash. You’ll see that the plan works in any account, even a 401(k). Finally, you’ll watch it alongside other investment approaches in a real-life scenario that brings together everything you’ve learned.

13 Comments

I have read your books and am interested in implementing the 3% plan in my IRA that has $75,000.
I have a few questions given the current market.
I’m hesitant to put all the money into the plan right now considering the market may turn. According to the wait for buy signals, this last quarter should count? I’m also hesitant to wait a full 4 quarters to fully invest since that seems like it would take forever. Or should I wait until June to start? and do you think it would be fine to just do it across two quarter buy signals rather than 4?

Also regarding the bond. I have TD ameritrade which doesnt have VFIIX. I found MPV long term bond fund which seems similar. I invested some a week ago and it lost 3% in just a week…. I thought it was supposed to be a stable source of income but now that i think about it it doesnt seem very stable especially with interest rates about to rise. So I am pondering an alternative…

I was curious as to your opinion regarding using lending club as the stable income source. It returns a steady 7-9%. It’s not entirely liquid but generates steady liquid returns and in the case of a really down market, the remaining notes could be sold in after market to put more money into IJR.

I am thinking about a more aggressive plan of 50% lending club and 50% IJR. With more a 4% goal of return per quarter. With $35,000 invested in Lending club it makes it more liquid with about $2200/quarter generated from loan payments. Plus I will have the IRA contribution of $1375/month.

Yes, moving in across two quarterly buy signals will be fine, if you’re fine with it. The main benefit of spreading it across four quarters is a psychological one for the investor. As long as you don’t mind moving all of your capital in with two buy signals rather than four, then go for it. In most time periods, doing so would be just fine. In fact, in most time periods, going all-in immediately on the first buy signal is fine.

You’re not supposed to use a long-term bond fund. From the bottom paragraph on page 86: “…a total bond market fund such as BND or an intermediate-term bond fund such as BIV is best. These are as evergreen as they come, usually near the middle of the pack, very cheap, and do exactly what we expect bond funds to do.” The disccussion and Table 13 preceding this excerpt show the tradeoffs among bond funds, specifically: “Long-term bonds offer higher yields and strong long-term performances but are more sensitive to interest rate fluctuation.” This is what nailed you. Stick with a total bond or intermediate-term bond fund.

I have no opinion on Lending Club. This doesn’t mean it’s necessarily a bad choice, just that I haven’t researched it or tested it in historical reviews of the plan. I suspect that your “more aggressive” version of the plan with a 50/50 allocation to Lending Club and IJR would end up less aggressive than the default 3Sig plan’s higher allocation to IJR. The bond fund isn’t for growth or performance enhancement, it’s for a trickle of income from capital stored relatively safely for buying power at opportune times signaled by the plan. Trying to enhance performance by tweaking the bond side of the plan is missing the point. If you want a more aggressive version of the plan, a leveraged index for growth is a better bet. This is what I run in Tier 2 of my letter, but I’m not as confident in it as I am in the base case 3Sig plan run in Tier 1.

You’re likely to find that at the end of experimentation, you’ll end up doing worse than by just following the easy base case of the plan. The stones in this part of the investing river have been thoroughly turned.

Hi Jason, I just finished reading your book. I’m just thinking of starting to invest.
I’m from Myanmar so my options are very limited here. The best alternative will be for me to go to Singapore and invest in US ETFs there. Do you have tips for international investors like me who do not have tax deferred or tax free retirement accounts?
I would like to know more about how to deal with tax in regards to dividends, short term sales of stocks and bonds.
Thanks so much
Aung

I used to try replying to all of the international requests with plans, Aung, but it became too time consuming. I don’t have the bandwidth to research the best way to run the plan outside of North America. If you can open an account that trades US ETFs at a reasonable cost, do so! If not, go with the cheapest available stock index fund and bond index fund in your local account. Index funds work the same everywhere, so this is a universal tip. The math of 3Sig works the same way regardless of the indexes used in it.

I just finished reading The 3% Signal and found it to be extremely convincing – I plan on starting the plan at the start of next month, which will be the beginning of 2016, with my 401(k) account. Quick question I was hoping you could clarify for me – since I’m still working, I’m still making regular contributions – when it comes to adding new cash to the plan, do I move 50% of my quarterly contribution to the stock fund each quarter, regardless of what the signal is indicating, or do I ONLY do that on a BUY signal? In other words, if the signal is not indicating BUY, do I leave 100% of my quarterly contribution in the bond fund?

By the way, I just want to point out that your plan also plays well with the ‘excessive trading’ restrictions that my plan (and possibly others) imposes – another good reason for quarterly, versus more frequent, adjustments.

Yes, I agree that the quarterly pace of the plan gets around all excessive trading restrictions. It keeps costs low, too, and is just better than the usual frenzy in every way.

As for new cash, all of it goes into the bond fund initially. It’s drawn into the stock fund only with buy signals. For more on this, see “The Modified Growth Target” on page 137, particularly the formula on the top of page 139. The 50% of cash value is added to the growth target for the quarter, not to the stock fund as you add more cash to the plan. The 3Sig calculator automatically handles this for you (jasonkelly.com/3sig/).

Your 401(k) is the perfect place to run 3Sig, and I wish you well with it!

The market cap indexes come into and out of favor in different time periods, but they’ve always done so and small- and mid-caps come out on top over time. We’re already seeing evidence of this. From the end of January through the end of April, the S&P 500 gained 6.5% while the Russell 2000 index of small companies gained 9.2%.

More important, however, is that The 3% Signal is designed to use the greater volatility of small caps to its advantage. It wants wider fluctuation, not less, because it automatically buys more when prices are weak and sells more when they’re strong. Mathematically, the plan performs better when prices fall farther and then rebound higher. More than the overall greater performance of small caps over time, it’s their higher volatility that makes them preferable for this superb automated plan.

Indeed the NEATEST guide that eliminates the guess work and anxiety out of Investing. I can’t believe that it can be so Simple. I have tried it on the Indian Markets and the result is amazing. A book worth recommending to your near ones.

There’s nothing wrong with following in the footsteps of gurus, but I’ve grown disenchanted with the all chance-based approaches to the market, in which somebody tries to guess what a future stock price will be (regardless of method, this is all they’re ultimately doing). I run all price-reactive approaches now, and the results are far better with much less stress.

For an update, see:

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If you do decide to pursue valuation and fundamental analysis with a portfolio of individual stocks that you buy and sell, Guru Focus is as good as any other site for doing so.

I started using the 3% signal in my 401k around September 2015. Results are far superior to the Lifepath2030 blended fund I was using and ignoring for the past 10 years. If only I read your book sooner, I’d retire sooner. Better late than never, though.

So, I’m trying to figure out why I wouldn’t just use the 2nd tier investment (6% on MVV, 50/50 allocation) in my 401k instead. I’m not going to be drawing from it for at least another 20 years. Is it that most people get too nervous with the longer ups and downs with the 2nd tier? Or is it not as reliable or something? My 3% plan is waiting for a buy signal to rebalance. I’m considering just taking the excess bond fund and putting half of it in MVV to start the 2nd tier. Then, I’ll stop contributing to the 3% one and start contributing to 6%. Are there reasons I shouldn’t do this?